China’s bad loans: $1.2 trillion or a mere $400 billion?
In a post we did earlier in the year entitled China’s cooked books scare the heck out of us, we quoted the commonly used figure of $400 billion on bad debts plaguing China’s banking sector. Then we speculated a couple of months ago that China’s soaring money supply growth was orchestrated in part to support the banking sector during the slew of IPO’s being underwritten for China’s banks — the last thing you want when restructuring the banking sector is a credit and liquidity crunch.
It turns out that the real news is far worse — three times as bad — than we and others have thought. According the Ernst & Young (via the Austrialian) China’s banking system is out of control with bad loans and corruption, to the tune of $1.2 trillion in bum assets:
According to Ernst & Young, the accounting firm, bad loans in the Chinese financial system have reached a staggering $US911 billion ($1.18 trillion), including $US225 billion in potential future NPLs in the four largest state-owned banks.
This equals 40 per cent of gross domestic product and China has already spent the equivalent of 25-30 per cent of GDP in previous bank bail-outs.
The revelation shows that half-hearted reforms have addressed merely the symptoms of China’s financial fragility. Poor business practices are blamed for NPLs but the real source is political. As long as the communist party relies on state-controlled banks to maintain an unreformed core of a command economy, Chinese banks will make more bad loans.
Systemic economic waste, bank lending practices, political patronage and the survival of a one-party state are inseparably intertwined in China. The party can no longer secure the loyalty of its 70 million members through ideological indoctrination; instead, it uses material perks and careers in government and state-owned enterprises (SOEs). That is why, after nearly 30 years of economic reform, the state still owns 56 per cent of the fixed capital stock. The unreformed core of the economy is the base of political patronage.
Government figures show that, in 2003, 5.3 million party officials held executive positions in SOEs. The party appoints about 80 per cent of the chief executives in SOEs and 56 per cent of all senior corporate executives. Recent corporate governance reforms, Western-style on paper but not in substance, have made no difference. At 70 per cent of the large and medium-sized SOEs ostensibly restructured into Western-style companies, members of party committees were appointed to the boards. Painful restructuring appears to have spared this elite. China has shed more than 30 million industrial jobs since the late 1990s but few party officials have become jobless.
It is perhaps no surprise that China is planning to swiftly introduce bank deposit insurance, one of the key reforms of the early New Deal to stem the runs on banks, via WSJ:
China is preparing a system to insure bank deposits, underscoring official concern about rapid changes in its financial system. But the plan is causing anxiety at foreign banks as it might require them to incorporate branches within China, which would be costly and inject new uncertainties into their nascent China operations.
Officials of the China Banking Regulatory Commission say the agency is working on plans to introduce a system like the U.S. Federal Deposit Insurance Corp., which is designed to protect American depositors in case of a bank failure.
The plan, according to commission officials and to bankers and analysts briefed on it, is part of an effort to prepare China’s financial system for December, when Beijing has pledged to the World Trade Organization to start letting foreign banks take deposits in yuan.
In business it is really hard to be off in an estimate by a factor of three — let alone when the mistake is an $800 billion one. This sounds very serious, if the E&Y numbers are accurate, and far more questionable than China’s revaluing its GDP by 17% earlier this year. We’ll keep you posted.
UPDATE
China’s central bank denied it all, via WSJ:
China’s central bank rejected a research report that nonperforming loans in the country’s banking system could be as high as $900 billion. “The overseas accounting firm’s so-called research report…not only greatly distorted the current asset quality of China’s banking industry, but also has great discrepancy with its audit results on many Chinese financial institutions,” an unnamed official at the financial-stability bureau of the People’s Bank of China, said in a statement published on the PBOC’s Web site. The PBOC didn’t name the accounting firm. Earlier this month, media reports, citing a study by New York-based Ernst & Young LLP, said China’s banking-debt problem is far worse than official estimates indicate. The reports said nonperforming loans for China’s Big Four banks alone were valued at $358 billion, more than double the government’s figure, and the total for the banking system could be as high as $900 billion. The PBOC statement said that China is pushing forward its financial reform and development, and that internal controls and risk-management abilities in financial institutions have strengthened, asset quality has improved, and capital-adequacy ratios have increased steadily. The Chinese banking sector’s NPL ratio fell to 8% at the end of the first quarter from 8.6% at the beginning of the year, the central-bank statement said.